Seitz, Van Dusen and Adams, Circuit Judges.
We are asked to decide in this case whether the Tax Court erred in finding that a taxpayer did not have a sufficient "economic interest" in certain Pennsylvania coal deposits to qualify for the depletion deduction provided by the Internal Revenue Code of 1954. 26 U.S.C.A. §§ 611, 613.*fn1
The taxpayer, Mrs. Costantino, is engaged under the name of Costantino Company in the business of strip-mining coal. On November, 1, 1954, Mrs. Costantino entered into a written contract with the Reitz Coal Company (Reitz) for the strip-mining of coal owned or leased by Reitz in Somerset County, Pennsylvania. Reitz, a Pennsylvania Corporation, at the times in question was engaged in the mining and sale of coal.
The 1954 contract between Reitz and Costantino stated that Reitz was the owner or lessee of grade "B" coal underlying certain parcels of land, and provided that Costantino was to strip-mine grade "B" coal underlying such land and to deliver the coal to Reitz. Mrs. Costantino was not required to mine the coal to exhaustion but only to excavate the coal as far as "practicable." Reitz, in turn, promised to pay Costantino $2.60*fn2 per ton of coal delivered. Although the contract set forth no expiration date, by its terms it was terminable at will by either party upon one month's notice. On March 1, 1965, the 1954 contract was slightly modified to refer to grade "C" coal as well as grade "B"*fn3 coal, and its substance reaffirmed.
During the years 1961-1963, Mrs. Costantino mined coal from land owned or leased by Reitz. In 1961 the coal mined was divided between grade "B" and grade "C" coal and in 1962 and 1963 most of the coal mined was grade "C." Mrs. Costantino utilized her own equipment and hired her own crew of workers to operate the equipment, and the cost of the equipment was depreciated on her tax returns for the years in question. Also, Mrs. Costantino claimed on her tax returns the statutory ten percent coal depletion allowance.*fn4 The Commissioner of Internal Revenue disallowed the claim for the statutory depletion allowance and assessed Mrs. Costantino accordingly. For 1962 she was assessed a deficiency of $15,939.55 and for 1963 a deficiency of $16,448.13. Thereafter, Mrs. Costantino filed a petition for redetermination in the Tax Court. The Tax Court affirmed the Commissioner's assessment.
On appeal from the Tax Court's decision, Mrs. Costantino contends that its finding that the 1954 written contract controlled her business relations with Reitz during the years 1961-1963 is clearly erroneous.*fn5 At the trial before the Tax Court, Mrs. Costantino presented evidence tending to prove the existence of an oral contract between Reitz and herself which superseded and modified the 1954 written contract.*fn6 Moreover, Mrs. Costantino argues that the 1954 written contract was in any event inapplicable to the mining operation during 1961-1963, because during those years grade "C" coal was mined -- whereas the written contract, as noted earlier, referred only to grade "B" coal. Nevertheless, the Tax Court found as a fact that the mining operation was carried on pursuant to the written contract.*fn6a The Tax Court based its ultimate finding upon the fact that the process by which grade "C" coal is extracted is substantially identical to that of mining grade "B" coal. Further, the Tax Court considered the 1965 "extension" of the 1954 written contract and a letter written to the Director of Internal Revenue, Pittsburgh, Pennsylvania, by the manager of Costantino Company, Don Batiste, stating that the only contract between the Costantino Company and Reitz was the "1954 written agreement" and the "1965 extension." Under these circumstances, we cannot hold to be clearly erroneous the Tax Court's finding of fact that the 1954 contract controlled the relationship between the parties.
Mrs. Costantino asserts that the Tax Court "may not disregard * * * uncontroverted and unimpeached testimony * * *,"*fn7 referring to the testimony of her witnesses who asserted the existence of an oral contract. The rule which she cites is not, however, applicable in the present case, because, as we have seen, there was evidence before the Tax Court which would justify its decision not to credit the proffered testimony to the effect that the existence of an oral agreement superseded and replaced the written one.
Mrs. Costantino also asserts that under Pennsylvania law the contracts with Reitz provided her with a fee simple interest in the coal beds, and consequently she was eligible for the coal depletion allowance. Such claim is subject to serious doubt. To support her analysis of Pennsylvania law, Mrs. Costantino refers to Smith v. Glen Alden Coal Co., 347 Pa. 290, 32 A. 2d 227 (1943); Brown v. Haight, 435 Pa. 12, 255 A. 2d 508 (1969), and School District of Borough of Shenandoah v. City of Philadelphia, 367 Pa. 180, 79 A. 2d 433 (1951). However, the contracts in those cases relating to the right to extract minerals are distinguishable from the present contract, because the present contract was terminable at will and the contracts considered in the foregoing cases were not so terminable. Moreover, Mrs. Costantino did not have a duty to mine until the coal beds were exhausted, which apparently is one of the hallmarks in Pennsylvania, a fee simple interest in minerals. Smith v. Glen Alden, supra, 32 A. 2d at 232.
In any event, controlling decisions of the Supreme Court indicate that federal, not state, law governs eligibility for the depletion allowance. In Palmer v. Bender, 287 U.S. 551, 557-558, 53 S. Ct. 225, 227, 77 L. Ed. 489 (1933), the Supreme Court noted:
"Similarly, the lessor's right to a depletion allowance does not depend upon his retention of ownership or any other particular form of legal interest in the mineral content of the land. * * * Thus, we have recently held that the lessor is entitled to a depletion allowance on bonus and royalties, although by the local law ownership of the minerals in place passed from the lessor upon the execution of the lease."*fn8
Hence, the touchstone of eligibility for a depletion allowance is whether the claimant of the allowance has acquired "an economic interest in the coal in place" and not the characterization of the relevant interest by the state where such interest is located. Paragon Jewel Coal Co. v. C.I.R., 380 U.S. 624 at 633, 85 S. Ct. 1207, 14 L. Ed. 2d 116; Palmer v. Bender, supra, see Whitmer v. C.I.R., 443 F.2d 170 (3rd Cir. filed May 20, 1971).
The Congressional purpose of the statutory depletion allowance is to compensate the owner of wasting assets, such as mineral deposits, for the portion exhausted so that the owner's capital remains unimpaired, and to prevent the unfair taxing of the return of capital as ordinary income. United States v. Cannelton Sewer Pipe Co., 364 U.S. 76, 81, 80 S. Ct. 1581, 4 L. Ed. 2d 1581 (1960); see Paragon Jewel Coal Co. v. C.I.R., supra, 380 U.S. at 631, 85 S. Ct. 1207 (1965). With such purpose in mind, the Supreme Court has formulated criteria to determine qualifications for the depletion allowance. Paragon ...